Credit Insurance & Variations

If you have a mortgage, personal loan or auto loan, you might have been offered credit life insurance from the lender. Not to be confused with traditional life insurance, credit life insurance promises to repay all or a portion of a revolving debt balance in the event you pass away. But, with limited flexibility and high costs, standard term life insurance might be a better option. So, if you’re considering a credit life insurance policy, here’s what you should know.


What is Credit Life Insurance? - Credit life insurance is a type of life insurance that’s designed to pay off the remaining balance of a person’s outstanding debt in case they pass away. Often, when you apply for a personal loan, mortgage, auto loan or a line of credit, lenders or banks will try to sell this type of life insurance.

If you purchase a policy, the lender or bank is the beneficiary of the policy and gets the payout, not your family. Credit life protects the interests of the lender.

Some of these policies are tied to the face value of the borrower’s debt balance. As you pay off your outstanding debt balance, the face value of the policy decreases. If you pass away, the proceeds of the policy pay off the remaining balance of the loan. Other policies may have a level death benefit, which means the death benefit will remain the same over the term length of the policy.

Generally, credit life insurance is a guaranteed issue life insurance policy, which means all applicants are approved for coverage regardless of their health conditions. Costs will depend on several factors including the type of credit and credit balance.

Advantages of Credit Life Insurance - The key benefit of a credit life insurance policy is that it will pay off a specific revolving debt balance if you pass away. There are several reasons why this could be beneficial.

Primarily, it could streamline the estate process. Typically, the executor of an estate reviews all of your assets and liabilities and then repays your debts with the available assets. If you purchase a credit life insurance policy, the executor won’t have to use your financial resources to repay that specific debt balance.

Another benefit is that a credit life insurance policy can help a co-signer, joint account holder or spouse (if you live in a community property state). If you pass away, these individuals would be financially responsible for repaying an outstanding debt balance. A credit life insurance policy would relieve them of this financial obligation.

Additionally, you can purchase a credit life insurance policy even if you’re not in good health. Whether you have a chronic medical condition or you’re ineligible for a term life insurance policy at an affordable rate for other reasons, there’s no health exam required to qualify for credit life insurance.

Disadvantages of Credit Life Insurance - While the benefits of credit life insurance may have some appeal, the disadvantages could outweigh the upside. Here are some to consider.

First, since the lender typically sells you the policy, the policy’s premium will be folded into your monthly loan payment. In some cases, the lender will add a single lump sum premium to your loan balance, meaning you’ll be paying interest on your credit life insurance premiums for the life of the loan.

Second, many credit life insurance policies have a diminishing face value. As you pay down your loan balance, you’ll still pay the same premium but for less coverage. For example, if you had a $50,000 loan balance at the outset of the policy and paid off $30,000, you would still pay the same credit life insurance premium for $20,000 worth of coverage.

Another downside to this policy is that credit life insurance is designed with one purpose in mind: to repay a specific debt, such as a personal loan. A payout will not wipe out all of your debt (like car loans, credit cards and student loans).

Credit life insurance also lacks flexibility for the death payout. A payout goes directly to the lender. Since your family doesn’t receive the money, they don’t have the option to use the funds for other purposes.

Can I Cancel My Credit Life Insurance? - While rules may vary by the insurance provider, you should be able to cancel a credit life insurance policy at any time. Depending on when you cancel, you might be eligible for a full or partial refund. Generally, your refund will be calculated by the Rule of 78 or a pro-rata method.

Rule of 78: With the Rule of 78, lenders calculate interest for the entire term of the loan and then assign a share of that interest to each month. If your lender uses this method and you have a 12-month loan, they would add the numbers 1 through 12 together, which equals 78. 

Next, they would assign a portion of the interest to each month in reverse order. Therefore, the first month the borrower may pay 12/78th of the interest of the loan and so on.

Pro-rata: The pro-rata method is a little easier to understand. Let’s say you cancel your credit life insurance at the beginning of the 6th month of coverage but you have paid for the entire year. With the pro-rata method, you may get a 50% refund on the policy.

If you pay off the debt early, you may also be entitled to a refund or credit for the unused premium payments.

Some lenders may offer a “free” introductory period for 30 to 90 days. But if you want to cancel, you will be responsible for taking action. If you forget to cancel after the introductory period, you may not receive a full refund for the policy.

Other Types of Credit Insurance Policies - In addition to credit life insurance, there are other types of credit insurance policies you may want to be aware of:

Credit disability insurance: This pays for all or a portion of your monthly loan payment in the event you become ill or injured and cannot work during the policy term. Often, there is a waiting period before your policy benefits kick in (such as a 14-day waiting period). Some credit life insurance policies may also pay off your debt in the event you are disabled and no longer able to work.

Credit involuntary unemployment insurance: Also known as involuntary loss of income insurance, this insurance policy pays all or part of your monthly loan payments in the event you lose your job through no fault of your own, such as a layoff.

Credit property insurance: This policy protects your personal property used to secure a loan if it’s destroyed by an event such as theft, accident or natural disaster. But before you buy this credit property insurance type, take a look at your homeowners insurance policy or renter’s insurance policy. If you have a comprehensive policy, buying credit property insurance might duplicate your existing coverage.

Term Life Insurance as an Alternative - In many cases, credit life insurance isn’t the best option. Term life insurance is generally a less expensive and a better solution, especially if you’re on the healthy side.. Since term life insurance policies are “medically underwritten,” your cost is determined by factors such as your age, gender and health. Generally, the younger and healthier you are, the less you’ll pay for a term life policy. But affordable term life is also available at older ages and for people with some health conditions.

In addition, term life insurance allows more financial flexibility. You get to select your beneficiary and your beneficiary gets to decide how to use the death benefit money. For example, your beneficiary could use the money to pay off a mortgage, medical expenses or student debt.

Another consideration: Term life insurance doesn’t have a diminishing face value. If you purchase a $500,000 policy, that’s what your beneficiary will get if you pass away within the policy term. That’s a big difference from credit life insurance. With credit life insurance, your coverage amount reduces as you pay down the loan balance.